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2. (a) Are stock prices affected more by long-term or short-term performance? Explain. (b) A stock...

2. (a) Are stock prices affected more by long-term or short-term performance? Explain.

(b) A stock is expected to pay a dividend of RM2 at the end of the year. The required rate of return is rs = 12%. What would the stock’s price be if the growth rate were 4%? What would the stock’s price be if the growth rate were 0%?

3. If D0 = RM4.00, rs = 9%, and g = 5% for a constant growth stock, what are the stock’s expected dividend yield and capital gains yield for the coming year?

4. (a) Explain what is meant by the terms “horizon (terminal) date” and “horizon (terminal) value”.

(b)Suppose D0 = RM5.00 and rs = 10%. The expected growth rate from Year 0 to Year 1 (g0 to 1) = 20%, the expected growth rate from Year 1 to Year 2 (g1 to 2) = 10%, and the constant rate beyond Year 2 is gn = 5%. What are the expected dividends for Year 1 and Year 2? What is the expected horizon value price at Year 2? What is the expected P0?

5. (a) A bond that pays interest forever and has no maturity date is a perpetual bond, also called a perpetuity or a consol. In what respect is a perpetual bond similar to (i) a non-growth common stock and (ii) a share of preferred stock?

(b) A preferred stock has an annual dividend of RM5. The required return is 8%. What is the Vps.

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Answer #1

2a: Stock prices are affected more by long term performance. Over time short term performance and short term price swings of a stock gets smoothed out. In the long run news and market reaction become less important. What drives stock prices are two main factors of long term performance. These factors are earnings of the company and its growth. Earnings refer to the ability of the company to earn money and this ability drives its long term success or failure. Growth refers to the ability of the company to grow its earnings. Stocks of companies with growing based earnings are usually more in demand by investors.

2b: Here D1 = 2, r = 12% and g = 4%.

Thus stock’s price = D1/r-g

= 2/(12%-4%)

= RM 25.00

Now in case growth is 0% then price = 2/(12%-0%)

= RM 16.67

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